What Are the Pro’s and Cons of a Sale/Leaseback?

An alternative financing option in commercial real estate.

Although real estate ownership for businesses is profitable in growing markets, with an increase in the value of the property and reduced debt through loan repayment, many businesses need additional capital to thrive in inflationary times like we are experiencing now. Whether the business is purchasing new equipment, adding new products, or making renovations, costs have increased, and this means it may be time to add new debt to the balance sheet. Debating this does not have to give you a stomachache!

You have heard of the infamous “sale/leaseback” transaction which is being used more frequently to supply additional capital without increasing the company’s debt load and monthly mortgage commitments. History shows that this type of transaction has been extremely popular among the big retail and industrial chains.

It is a simple equation and requires little, to any physical transition. The business property is sold to a third-party investor who agrees to lease the property to the original owners who become the tenant. This enables owners of commercial property to put their appreciated equity to work in other areas of the business. So rather than just waiting for the building to appreciate and reap the rewards, more can be realized because the value of the equity applied to the business in real-time will typically results in a better bottom line overall.

There are always two views to how a business approaches property – similar to the concept of car ownership habits – (either you believe in owning or you believe in leasing), in the case of business this largely depends on the type of business and related activities. Nevertheless, any investment is really about a return on the equity invested. With cash or other assets invested into commercial real estate, you are principally relying on the income generated, along with the mortgage reduction, and the depreciation – all of which we assume will provide that return and increase the equity in the property; something we term value appreciation. However, we have learned never to take things for granted – nothing is ever guaranteed.

So, the pros and cons boil down to the particular business and what stage in the life cycle they are at. Professional practices such as CPAs, attorneys and physicians frequently use these transactions to avoid constant valuations as partners retire and new ones join. For the general business, the advantage is that a sale/leaseback may produce more actual cash than a traditional loan. Under this structure, an owner can usually receive 100% or more of the appraised value in a sale-leaseback. The real estate value can also be affected by the terms of the sale-leaseback. Higher rent for a longer term (assuming the seller tenant is creditworthy) will usually lead to higher values.

The cons include the concern about having solid business advice so that the lease rate does not outweigh the value that could be realized by holding the property or borrowing against the property. And there is the human side of the transaction; committing to the new owner means a new dynamic between parties so it is important to have a Maven at your side to walk you through all the numbers and risks.

The aspect of timing is important to consider. The current demand for net-leased investments is at a historic high, especially in the industrial space – this is driving cap rates down & prices up. Interest rates are climbing but have yet to echo the double digits we have experienced in the past. At this point, they remain relatively low and desirable to investors who have been holding onto cash waiting for the squeeze to bring opportunities forward. Additionally, the returns that foreign investors can achieve in Canadian real estate are far greater than the returns in many overseas markets. As the banks tighten their lending belts because of new regulations like the foreign buyer ban  in the residential market or the Basel III rules, this opportune timing may be limited. If your business could use an analysis of what the sale/leaseback would mean to your bottom line and future, Maven CRE is the partner that will walk you through the pros and cons as they apply to you.